Vulnerable Mortgages and the Depegging of the Chinese Yuan-

"May you live in interesting times . . . "


Yesterday’s announcement of the de-pegging of the Yuan to the US dollar had an immediate impact: Bonds across the yield curve all rose about 10 basis points. As we noted yesterday morning:

"the Real Estate Complex
has been the most robust segment of the U.S. economy. If the Chinese
can succeed (where the Fed failed) in raising U.S. long rates, the
part of the US economy is at risk. While we know real estate had to
slow eventually,
the question is how fast will it occur, and how dramatically."

That’s my key takeaway from this entire issue. Why? Because I doubt it will impact exports much — given that the massive wage disparities and cost structure differentials are so significant, a 2% (or even a 12%) currency change won’t amount to a whole lot, relative to imports.

The position I’ve staked out (vis-a-vis Real Estate and the Economy) is decidely in the minority. To reiterate:

1) Real Estate is a very different type of asset than stocks;
2) Housing is not a bubble — rather, it is an extended asset class — and therefore is vulnerable to a 25-35% retracement, as opposed to a Nasdaq like 80% crash;
3) The rest of the economy is mediocre; Back out Housing Related activity, and there’s not a whole lot of there there.

We’ve been beating that drum for many months now. Finally, the meme that Real Estate has been driving the economy has only recently received widespread attention.

So the currency shift, and its resultant impact on long rates (and therefore Real Estate), plays very much into our Bearish 2006 scenario.

Consider the Yuan depegging in light of the increasing number of "exotic" mortgages:  30-Year Fixed mortgages are down to just over 40% from ~70% of all mortgages;  Adjustable mortgages, up from under 10% to over 40%; Interest only mortgages, up to 20% — from 0 in 2001.

Its hardly intelligent to take an APR when rates are at half century lows; Interest only mortgage holders don’t really own their homes — they are more like renters with an option to buy. Hey, that’s the free market — people are free to be as dumb a they want to be.   

Where it becomes a macro-concern is that all these loans get sold, securitized and packaged, courtesy of Sallie Fannie Mae and Freddie Mac. If we see a big wave of defaults, that could have deep and far reaching ramifications on the country’s capital markets.

Have a look at a recent WSJ discussion of related topics:

Mortgage_rates_wsj_2WSJ:  ". . . offering alluring and controversial mortgages that require unusually slim payments for a few years, before bigger sums fall due. Some customers use these loans to borrow as much as seven times their annual income — a staggering jump from the two-times-annual-income level that was the rule of thumb when the 30-year fixed-rate mortgage was the norm.

As real-estate mania intensifies, the mortgage industry keeps making it easier to borrow. "Low documentation" loans are catching on, including ones where lenders simply take borrowers’ word about their income and don’t ask for pay stubs. Repayment terms sometimes are stretched as long as 40 years, to help shrink monthly payments. In the most common twist, lenders aren’t requiring even token efforts to repay principal in the early years of a mortgage. Interest-only payments suffice. In some cases, borrowers can even pay less than that, allowing interest to pile up and be repaid later.

Skeptics worry that this easy-credit euphoria could end with a real-estate crash and waves of problem loans. Federal Reserve Board Chairman Alan Greenspan warned in June that housing prices in some areas appeared "unsustainable," adding that he was concerned about "the dramatic increase in the prevalence of interest-only loans." In a recent Wall Street Journal survey of 56 leading economists, 11 named a possible housing bust as their biggest worry for the economy."


Equally disturbing: Most of Wall Street and Washington D.C. have applauded this. So far, I’ve found only myself — and John Rutledge — are overly concerned with the negative  impact of this development. At least it will be fascinating to watch how this unfolds over the next 18 months.

Its ironic: "May you live in interesting times" is considered a curse — by the Chinese.   


Easy Money: A Mortgage Salesman’s Pitch
Mr. Ray Touts Low Payments For the First Five Years;
Interest Keeps Piling Up A Chance to Buy That Escalade

THE WALL STREET JOURNAL, July 20, 2005; Page A1,,SB112182276862990316,00.html

Washington, Wall Street React To Chinese Yuan Revaluation
July 21, 2005 1:26 p.m.,,SB112195563846692122,00.html

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What's been said:

Discussions found on the web:
  1. zwz commented on Jul 22

    “Housing is not a bubble — rather, it is an extended asset class — and therefore is vulnerable to a 25-35% retracement, as opposed to a Nasdaq like 80% crash”

    House Price may not be a bubble, but housing stocks could become one.

  2. stockman commented on Jul 22

    TH’s are stressing that the currency exchange rate adjustment will be ‘controlled’ and gradual . That is likely to be the case, however the free markets could move to discount the impact that they see likely to unfold over the next 6-12 months NOW. In theory some have suggested that the slowing of treasury purchases by Asian bankers could add 50 -75 bps to the long end over the next 6-12 months . The market is likely to price this in sooner rather than later. If yesterday was a start of this larger move stocks (and bonds) are in for tough sledding here.

  3. stockman commented on Jul 22

    25-30% retracement would wipe out 100% of the equity for many buyers of 2003-2005. Certainly owners equity is at risk for a NASDAQ type decline IF we get that ‘retracement’.

  4. Barry Ritholtz commented on Jul 22

    Yes, but — under even normal circumstances, home buyers only put up 10% or so.

    If house prices drop, they are upsidedown (as an investment) — but as long as they make their monthly payments, they can wait it out the decade or so it will take to get to breakeven.

    The real threat is if people start losing jobs — then wholesale mortgage defaults becomes the real problem.

    And, they dont have to worry about a margin call!

  5. royce commented on Jul 22

    One thing to consider with the new prevalance of ARMs is the way raising rates would encourage more sales than in the past. If you can’t make the new, higher payment and rents are relatively lower, you’re going to sell the house to get out from under the loan. That increases supply just as rising rates are reducing the amount buyers can pay.

  6. kdawg commented on Jul 22

    Besides Rutledge, Dr. Nouriel Roubini also addressed the negative impact on the U.S. housing market in the Econoblog debate yesterday :,,SB112195421057192103,00.html

  7. hans commented on Jul 23

    Who says the Fed is raising rates? Rates bottomed and turned up a year before Greenspan started “tightening”. Greenspan must be trying to SLOW the necessary rise in rates….and failing. When you’re about to be tarred and feathered and run out of town, you get out in front of the mob and pretend its a parade in your honor!

  8. Harry Schneit commented on Sep 12

    to resolve a personal debate i woud just like to know what % of U.S.A. mortgages are owned by the chinese?

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